Silicon Valley Bank has provided fund finance to private equity and venture capital firms for more than 30 years. As head of SVB’s global fund banking team for EMEA, and previously Barclays’ European private equity funds team, Gavin Rees has seen his fair share of lending.
He spoke to Private Equity International about the implications of the Abraaj Group saga, enhancements in underwriting, changing LP bases and fee structures.
What are the biggest challenges in fund finance?
The headlines about Abraaj have been prominent recently, so it’s of very high importance to ensure security is taken correctly, documentation is watertight, that you are able to understand in full the investor base, have a degree of transparency in terms of the identities and the concentrations of those investors, rather than just treating them as a single pool.
From the borrower’s perspective, the important thing is to make sure that the facility you’re putting in place is something that gives you the flexibility to meet peaks and troughs in activity. Planning is very important; once investors have their money in the fund it’s very difficult at that stage to go back and alter partnership agreements to cater to these things, even if they are in the interest of investors.
How is the use of credit lines evolving?
There have been enhancements in the way underwriting and covenants work, as opposed to a loosening of standards.
A number of years back these facilities were issued on a commoditised basis. At the larger end of the market that’s still the case – they’re more cookie cutter – but as you move through to the small to mid-cap funds you see a greater variety of uses.
Managers are using these facilities to help support underlying portfolio companies, whereby the manager decides it doesn’t have all its non-recourse asset level financing lined up in the way it wants when it has to make the investment. So we put in place a facility at the portfolio company level, guaranteed by the fund [and] secured by the uncalled capital to help provide a bridge for maybe a year or two until it can get the right non-recourse financing in place.
Or [the manager] may do something like that if it’s deciding that it may well dispose of part of the investment in the early months, or say up to a year, and so doesn’t want to put in place the financing until the asset is performing at the level, and also size, it intends to keep in place.
Has the growing number of family office and high-net-worth limited partners made underwriting more complex?
For the capital call lines of credit, which form a large part of our business, you’re looking at the LPs’ uncalled commitments as your source of repayment and the security.
It’s very difficult to pull up financials relating to one particular family or HNW individual. You’re looking more at granularity of the investor pool and how much skin in the game the investors have at that point. This is one factor that goes into the decision-making.
But if you look at the track record of HNW investors in alternative funds, typically it’s the inability to fund as opposed to a disinclination to fund that causes investors to default and those numbers have been very low even during the financial crisis.
We have a good knowledge in terms of categories of investors and how they perform. So we can know the justification for a family office or an ultra-HNW individual to be a reliable counterparty in one of these funds, as opposed to just an entity which has a rating and you can then delegate your underwriting just to that.
How are the fees structured?
The majority of economics in these facilities is skewed towards when the facilities are used, as opposed to ongoing costs. Typically, you would see facilities in the range of 150 to 300 basis points in euro and sterling indices, but they vary according to the experience of the manager, the quality of the investor pool and the size of the facilities.